Reducing the deficit top priority
With the third largest budget deficit in the world, Italy needs its bond market to be more attractive than ever to investors. Now that Romano Prodi is officially in charge, the realities of sorting out the burgeoning deficit hit home hard. He has acknowledged that the public accounts are in their worst state since 1996 when the country had to make such huge efforts to prepare to enter the euro, a time when Prodi was Prime Minister. Bank of Italy Governor Mario Draghi has urged the government to cut the deficit, stating that real structural changes and spending cuts across the board would be the bare minimum.
The OECD, in its annual report, forecasts a budget deficit of 4.2% of GDP in 2006, rising to 4.6% in 2007.This is the fourth year running that Italy’s budget will overshoot the EU limit.
While it is quite clear that the debt situation has deteriorated badly in recent years, with over-spends and insufficient cost cutting leaving budget targets badly missed, the debt management agency cannot afford the same lacklustre show and instead has had continued success in its ongoing mission to streamline the government bond market, to improve the transparency and liquidity. The central government debt is managed by the public debt directorate within the department of the treasury within the ministry of economy and finance.
Liquidity in Italian government benchmark bonds is now as good as, the Italians argue it’s better than, that in the respective German and French markets. That they do trade this well is in large part due to the incredible compression in yield spreads seen over the past 14-15 years as convergence trends dominated all others. However, with such a huge debt burden to service, investors needed to be soothed all along. For example, electronic trading was first introduced in Italy back at the end of the 1980’s, so the market was very well prepared when euro MTS was introduced over 10-years later in 1999. The bond market was being steadily streamlined over the years, as smaller issues were bought back, and auction schedules thinned out greatly to focus issuance on big benchmark bonds.
Other notable achievements include the fact that foreign ownership of Italian government debt has increased very significantly in this time. Back in 1997, 17% was foreign owned, and by the end of 2004 that figure was up to 50%. And, like other indebted countries with a heavy (historical) reliance on short term debt, there has been a stated mission to increase the debt maturity profile. In 1993, the average life of the central government debt was just over 1.5years, by end 2005, it had climbed to 4.15 years, a hugely commendable achievement and one that many thought impossible, for ‘basket-case’ Italy.
Italy also joined the growing band of index-linked issuers in 2003 with the auction of a five-year bond linked to the inflation index within the Euro-zone. In September 2004, the auction system was introduced for linkers too and since then the treasury has regularly issued linkers, of five, 10 and 30-year maturity.
In the same way that Italian conventional bonds have been accepted as a sophisticated and reliable market, so too has the Italian index linked segment, representing a valuable and respected part of the global index linked market.